When looking for high-yielding stocks, one of the best places to look is in the midstream energy space. Many of these companies are regulated as Master Limited Partnerships (MLPs), Which pass through their profits to the unit owners and therefore do not pay corporate taxes.
As a result, most of them pay very generous dividends, which are similar to stock dividends, but many of the payments are considered a return of capital. This portion is tax deferred until the stock is sold and reduces the owner’s cost basis. This is a nice benefit, although it does add some paperwork at tax time.
The transport and rail sector as a whole has gone through a lot of changes over the past decade. In the past, firms often had a general partner (GP) and limited partner (LP) structure which was ultimately more beneficial to the general partner. The way it worked was that the general partners would own what were called incentive distribution rights (IDRs), while the general partner would pay the general partner a percentage of its distributions when it reached certain points.
This becomes very beneficial for the GP because once the MLPs reach a high 50/50 split, the GP will receive half of the additional distribution payments. For example, if a company raises its dividend by $0.02 per unit and that equals $10 million (500 million units vested multiplied by $0.02), it would also have to send the general partner an additional $10 million Under the IDR agreement. This structure also encouraged limited companies to finance growth by issuing more shares, as the more units the limited company had, the larger the dollar payouts also became.
By and large, this structure has been eliminated, and MLPs are generally in a better financial position as a result, holding less leverage and being able to grow their businesses through free cash flow. However, surprisingly, shares are trading at a discount today compared to where they traded under the old, unfavorable model. Between 2011 and 2016, shares of MLPs traded at an average multiple of 13.7 percent. Enterprise value-to EBITDA (earnings before interest, taxes, depreciation and amortization), which is the most common way to value these stocks.
Today, companies in this sector trade at much lower valuations even though the industry as a whole is in a much better position. This – coupled with the growing power demand from AI hardware in data centers – creates an excellent buying opportunity. Let’s take a look at two great MLPs to buy now.
Despite having some of the best assets in transportation with its large integrated system, Energy transfer(NYSE: ET) It is one of the cheapest multicaps in the space, trading at a forward EV/EBITDA multiple of 8.5. It currently has a forward yield of 6.4% and expects to increase its distribution by 3% to 5% annually.
Its distribution is also well covered, with a coverage ratio of 1.8x last quarter based on distributable cash flow (operating cash flow minus maintenance capex). It generated free cash flow of more than $165 million after paying the dividend.
Energy transportation also has some of the best growth opportunities in transportation. This stems in part from its strong presence in the Permian Basin, which gives it access to some of the cheapest natural gas in the country. The Permian Basin is primarily drilled for oil, and there have long been limitations on the ability to transport associated natural gas out of the basin. This results in very cheap regional rates and makes Texas an ideal area to build data centers.
Energy Transfer also owns the pipeline infrastructure to transport natural gas from the Waha Hub in West Texas to various other locations. As such, it said last quarter it saw inbound applications looking to connect about 45 power plants in 11 states to its pipeline system and more than 40 data centers proposed in 10 states.
The company also announced a new $2.7 billion Permian gas project that it said will help support data center growth in Texas.
Overall, Energy Transfer combines penny stocks with strong, well-covered distribution trading at a historically attractive price.
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Even in the days of the old MLP model, Enterprise Product Partners(NYSE: EBD) It has always been one of the most shareholder-friendly companies in the MLP space. It eliminated 50% IDRs in 2002 in favor of a 25% split and then scrapped them completely and collapsed its structure in 2011. The company has also always taken a more conservative approach to leverage and has maintained a strong balance sheet.
This has allowed the company to increase its distribution for 26 years in a row through various economic and energy cycles. The stock is currently yielding 6.4% and is trading at an attractive EV/EBITDA multiple of 10.
The company is currently starting to grow further due to the opportunities it sees. After cutting its growth capex to $1.6 billion in 2022 after the peak of the pandemic, it will spend about $3.5 billion to $4 billion in 2024. The company has generated an average annual return of 12% on its growth capex, paving the way for growth. The path to strong EBITDA increases in the coming years.
Enterprise Products Partners is also well positioned to capitalize on growing AI and data center energy needs with a strong presence in Texas, especially around the cities of Dallas and San Antonio, both of which are looking to become data center hubs. The company said that the energy demand coming from AI was one of the most promising signals it has seen in the natural gas sector in a long time, and that it has some of the best assets to be able to capitalize on this trend.
Overall, Enterprise Products Partners has proven to be a model of consistency and has plenty of opportunities while trading at an attractive valuation.
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Jeffrey Seller He has positions in Energy Transfer Partners and Enterprise Products. The Motley Fool recommends Enterprise Product Partners. The Motley Fool has Disclosure policy.
